The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that KSB SE & Co. KGaA (ETR:KSB) does use debt in its business. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is KSB SE KGaA's Debt?
The image below, which you can click on for greater detail, shows that KSB SE KGaA had debt of €42.3m at the end of June 2021, a reduction from €48.9m over a year. However, it does have €371.3m in cash offsetting this, leading to net cash of €329.0m.
A Look At KSB SE KGaA's Liabilities
According to the last reported balance sheet, KSB SE KGaA had liabilities of €738.1m due within 12 months, and liabilities of €720.4m due beyond 12 months. On the other hand, it had cash of €371.3m and €644.7m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by €442.5m.
This deficit isn't so bad because KSB SE KGaA is worth €747.1m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, KSB SE KGaA also has more cash than debt, so we're pretty confident it can manage its debt safely.
In addition to that, we're happy to report that KSB SE KGaA has boosted its EBIT by 73%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if KSB SE KGaA can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While KSB SE KGaA has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent three years, KSB SE KGaA recorded free cash flow worth 76% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While KSB SE KGaA does have more liabilities than liquid assets, it also has net cash of €329.0m. And we liked the look of last year's 73% year-on-year EBIT growth. So is KSB SE KGaA's debt a risk? It doesn't seem so to us. Over time, share prices tend to follow earnings per share, so if you're interested in KSB SE KGaA, you may well want to click here to check an interactive graph of its earnings per share history.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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